The United States real estate market is booming. Buyers generally outnumber sellers, and many smart entrepreneurs are taking advantage of opportunities to develop or rehabilitate residential and commercial real estate for profit. Real estate building and development is a regulated area, and all parties involved can face pitfalls if unfamiliar with local requirements. As a result, we are introducing the Construction Challenges Series, geared toward parties involved in construction projects. In Texas, owners of construction projects must be aware of the relevant laws governing construction projects to maximize returns on investment and avoid future liability, which can arise even when the owner acts in good faith toward all parties involved. In this article, Part 1 of the Series, we explain the statutory retainage obligations of owners of construction projects.
The Texas Property Code contains provisions regarding the obligations of an owner with regard to construction projects. These provisions aim to protect subcontractors in the event that they are not paid.
Statutory Retainage
Importantly, these provisions require an owner to hold back 10% of the total amount to be paid under the owner’s contract with the general contractor. Generally, this is called “Statutory Retainage.” The Statutory Retainage must be held by the owner of a project for 30 days after completion of the project, to secure the payment of subcontractors. During the 30-day period, as long as a subcontractor has complied with the notice provisions in the Texas Property Code, that subcontractor may place a lien on the owner’s property. After the 30-day period has expired, the owner may pay the Statutory Retainage to the general contractor, and the subcontractor generally no longer has a right to place a lien.
If an owner fails to keep the Statutory Retainage for the required period of time, the consequences can be severe. Texas courts have reasoned that when an owner fails to keep the Statutory Retainage, and the subcontractor has given notice to the owner and general contractor as required by the Texas Property Code, the 30-day limit on filing liens is not applicable. Hadnot v. Wenco Distributors, 961 S.W.2d 232 (Tex. App.—Hous.[1st Dist.] 1997). In that situation, the owner becomes personally liable to the subcontractor, and the subcontractor may file a lien for an amount less than the Statutory Retainage that should have been kept by the owner. Most of the time, the subcontractor’s claim is less than the Statutory Retainage amount, as subcontractors often perform a small portion of a very large project. Beyond legal liability, failing to hold an appropriate amount back from the general contractor will leave the owner without any funds to pay outstanding subcontractor invoices. Owners generally account for subcontractor invoices in their payments to general contractors, so failure to hold back retainage will likely result in the owner paying twice for the subcontractor’s work: once via payment to the general contractor, and again when held personally liable by the court for the subcontractor’s lien. Therefore, an owner’s failure to keep the Statutory Retainage can indefinitely extend the period of time for subcontractors to file liens, increase potential liability for the owner, and completely obliterate the owner’s bottom line for the project.
Technically Voluntary Withholding
An owner is authorized to withhold payment from the general contractor, if the owner receives a lien notice from a subcontractor. This amount can be in addition to the Statutory Retainage described above, and the owner is authorized to withhold the total amount that would be required to pay the subcontractor’s unpaid balance. If an owner withholds payment in this manner, the owner must hold the funds until the time allowed for filing a lien has passed; if a lien has already been filed, the owner must hold the funds until the lien is paid, bonded, or released.
While the law appears to give owners the option to withhold payment, the potential liability gives owners a serious incentive to withhold payment. If the owner receives notice of an unpaid balance from a subcontractor, and the subcontractor later places a lien, the owner can be legally responsible to the subcontractor for any amount that the owner paid to the general contractor after receiving notice from the subcontractor. Therefore, although holding back this additional amount is technically optional, failing to do so can expose the owner to additional financial responsibility to the subcontractor. As a result, it is best practice to withhold funds due to subcontractors when authorized.
Handling Retainage with General Contractors
Despite the above obligations of owners, general contractors expect payment per their contracts. Both of the above-described obligations require the owner to withhold payment to the general contractor. Failure to pay the general contractor as agreed is guaranteed to lead to a dispute with the general contractor.
For that reason, the owner must also ensure that the Statutory Retainage and the technically voluntary withholding are provided for in the owner’s contract with the general contractor. Special provisions must be inserted in any construction contract that allow the owner to hold the Statutory, and the owner must obtain the general contractor’s agreement to such terms. Some savvy owners include further provisions to protect themselves, including provisions that allow the owner to hold back amounts greater than the 10% required by law, and provisions that allow the owner to pay subcontractors directly, deducting the amount paid from the total due to the general contractor. Careful drafting is recommended to ensure that the owner has a robust fund from which to pay outstanding subcontractor invoices. We will discuss further specific contract protections for owners in a future article.
As is clear from this article, the laws governing construction can be challenging to navigate, and guidance from a skilled attorney is encouraged. The experienced attorneys at Onal Gallant & Partners can assist with understanding the complex world of construction law and ensuring that your project is both compliant and profitable. We have significant collective experience in drafting and litigating complex contracts and can guide you through the process of creating or amending a strong, effective contract for your next project. We have the skills and experience to provide effective representation in construction litigation, obtaining positive results for owners, general contractors, and subcontractors alike. Feel free to reach out to us for assistance and keep a lookout for our next installment in the Construction Challenges series.
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